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Mandatory Illinois Nonresident Withholding Begins with 2008 Tax Filings

Effective for taxable year ending on or after December 31, 2008, new withholding requirements apply to all pass-through entities with Illinois business income.

Who is required to withhold?

All pass-through entities that have Illinois income for a taxable year allocable to a nonresident partner, member, shareholder or beneficiary are required to make a pass-through entity payment on behalf of nonresident owners. A "pass-through entity" is a partnership, limited liability company, S corporation (S corp), estate or trust that is treated as a pass-through entity for federal income tax purposes. Note that members that are corporations and/or partnerships are always treated as Illinois nonresidents.

How do I file and pay the withholding?

Use Illinois Form IL-1000, Pass-through Entity Payment Income Tax Return. Illinois Form IL-1000 should be filed once per year and is due on the original due date of the entity's tax return (e.g., by March 15 for an S corporation and by April 15 for a trust or partnership with a calendar year-end). No extension may be obtained.

How much do I withhold?

The required amount of withholding is the nonresident owner's share of the entity's business income apportioned to Illinois for the taxable year, multiplied by the tax rate applicable to the owner. For individuals, this tax rate is 3%.

This "withholding" is on the distributive share of the nonresident owner's Illinois income and not on the actual distribution made. Withholding is due to the Illinois Department of Revenue even if no cash distributions are made to the partner, shareholder or beneficiary.

Please note that Illinois withholding can result in non-pro-rata distributions. The withholding for an S corp is treated as a distribution. Consequently, a nonresident S-corp shareholder could have a distribution while a resident S-corp shareholder would not have a distribution.

What if I am overpaid or underpaid?

A pass-through entity may not claim a refund or credit for an overpayment of withholding due. The nonresident owner must file an Illinois tax return for credit or refund of any amount withheld.

If a pass-through entity fails to pay the full amount of withholding due, the amount underpaid will be subject to penalty and interest. The penalty rate is 2% for 1-30 days late and 10% for 31 or more days late. The interest charged is the "short-term federal rate" for the first year that the underpayment accrues interest.

How do the partners, shareholders and beneficiaries claim the pass-through payments?

Nonresident owners must be notified of any withholding payments made on their behalf by the pass-through entity of the amount (the amount paid will be shown on the Schedule K-1-P or K-1-T). If the partner's, shareholder's or beneficiary's Illinois income tax liability is fully satisfied by the pass-through entity payments, they are not required to file an Illinois income tax return. If a taxpayer does file an Illinois income tax return, they must include the income from the pass-through entity and will be allowed a credit for any Illinois income tax withheld on their behalf.

Who is exempt?

Pass-through entity payments are not required for nonresident members if:

• Their income is reported on a composite return, Form IL-1023-C (individuals only);
• They document to the pass-through entity on Form IL-1000-E, Certificate of Exemption for Pass-through Entity Payments, that they take responsibility for their tax obligations (this exemption does not apply to individuals); or
• The pass-through entity is a partnership classified as an investment partnership as defined in Section 1501(a)(11.5) of the Illinois Income Tax Act or publicly traded partnership under Section 7704 of the Internal Revenue Code of 1986

Recommendation

We recommend contacting Illinois nonresident owners now to see if they prefer to participate in an Illinois composite return, provide an exemption certificate or have the Illinois pass-through entity withhold taxes for them.

For more information, please contact Jason Parish at jparish@BlackmanKallick.com or 312-980-2959, or your Blackman Kallick representative. Our thanks to Deb Rood for her contribution to this article..

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.